IRS submits report to Congress, plans a 2024 limited Direct File Tax Return Prep pilot
The Internal Revenue Service submitted a report to Congress on May 16, 2023, evaluating a Direct File option for taxpayers and is taking steps to begin a pilot project for the 2024 filing season.
The report to Congress, required by the Inflation Reduction Act, evaluated the feasibility of providing taxpayers with the option of a free, voluntary, IRS-run electronic filing system, commonly referred to as “Direct File.”
The report focuses on three areas: taxpayer opinions, cost, and feasibility. It includes an analysis conducted by an independent third party, as required by the statute. The report also lays out the potential benefits and challenges associated with the IRS implementing a Direct File program.
What about the current IRS Free File option?
The IRS does currently offer a Free File Fillable Forms option in conjunction with its Free File program, but relatively few taxpayers use it. House Ways and Means Committee Chairman Richard Neal, D-Massachusetts, thinks the program will encourage more taxpayers to take advantage of free tax prep options.
"When 70% of taxpayers qualify for IRS's current Free File services, yet less than 3% take advantage, it's time for change," he said in a statement. "Today's report provides a framework for saving taxpayers time and money while giving them the experience they deserve."
Report findings: taxpayer opinions and interest in free Direct File
According to the IRS, the report finds that many taxpayers are interested in using a free IRS-provided tool to prepare and file taxes and that the agency is technically capable of delivering a Direct File program.
Other findings include that:
- Taxpayers are sensitive to cost, privacy, and security in their tax filing choices.
- Some taxpayers would be interested in using Direct File specifically because it would be built by the IRS.
- Some taxpayers report being concerned about the motives of the IRS in providing a Direct File tool and potential implications for tax enforcement.
- Taxpayers who currently self-prepare their taxes, are younger, or have limited English proficiency, are more likely to be interested in a Direct File tool.
- Taxpayers are least likely to adopt a Direct File option when they are comfortable with their current filing option.
- Taxpayer preferences regarding Direct File tend to be based on the assumption that a Direct File option would be about the same as or easier to use than other tax preparation software.
Report findings: Direct File option estimated costs
The report concludes that effective execution of a Direct File program would require sustained budget investment and careful management of the potential program's operational complexity.
Specifically, annual costs of Direct File were estimated to range from $64 million (assuming 5 million users and a narrow scope of covered tax situations) to $249 million (assuming 25 million users and a broad scope of covered tax situations).
The IRS states that customer support accounts for more than half of the cost in all scenarios and 84% of the cost in the 25 million users broad scope scenario.
Report findings: Free Direct File feasibility
The study highlights several operational challenges that the IRS must address if a decision were made to implement Direct File. These challenges include:
- Fostering technical product development expertise within the agency.
- Developing customer service capabilities to support taxpayers using the product.
- Coordinating with states and other stakeholders to support state tax administration.
It is unclear if Direct File would coordinate with state and local income tax returns. Failure to do so would force taxpayers to essentially do their income tax returns twice – once using the IRS system and another with existing private company software.
In an interview, former IRS Commissioner Charles Rossotti questioned whether Direct File is a good use of the agency’s resources, given the necessity to provide ongoing support for taxpayers with questions about filing their returns. “The last thing the IRS needs is more phone calls,” he said. He suggested it would make more sense to just cover the fees taxpayers pay for using private company software.
However, former commissioner Dave Kautter is quoted as saying the plan would fill an important gap in the tax system. “It is irrational that a taxpayer can’t file a tax return electronically directly with the IRS unless they go through a commercial software vendor.”
Does the IRS have the legal right to create the program?
The legality of the IRS direct-file tax preparation pilot program is a complex issue. There are a number of legal questions that need to be addressed, including:
- Does the IRS have the authority to offer a free direct-file tax preparation program?
- Does the program violate the anti-trust laws?
- Does the program violate the privacy rights of taxpayers?
The IRS has said that it believes that the program is legal. However, it is possible that the program could be challenged in court.
Many Republican members of Congress believe that the IRS should not act as a tax preparer, tax collector, and tax enforcer and question the legality of the Direct File program.
On the other hand, Democratic Congressional leaders and the administration believe the IRS has the legal authority to create such a system and believe it is a critical piece of simplifying the taxpayer experience and giving greater access to free tax return filing tools to underserved communities around the country.
The report: how data was gathered and the basis for IRS findings
The IRS report includes data from multiple sources. The report relied on information from the agency’s Taxpayer Experience Survey (TES), which surveyed thousands of taxpayers on these topics. The IRS also reviewed and incorporated findings from an independently conducted survey by the MITRE Corporation.
Data from the taxpayer surveys was supplemented with user research and usability testing, conducted using a basic internal prototype to better understand first-hand taxpayer perspectives.
The report also includes a separate, independent analysis done by New America and Professor Ariel Jurow Kleiman on the Direct File concept.
What’s next for the free Direct File pilot?
As directed by Treasury, the IRS will move to gather further information through the implementation of a scaled Direct File pilot in the 2024 filing season to further assess customer support and technology needs and the ability to overcome the potential operational challenges identified in the report. Additional details on the Direct File pilot will be available in the coming months.
“The IRS is committed to delivering significantly improved services by providing taxpayers with tools, information, and assistance to make it easier to comply with their tax filing obligations. Direct File – used by numerous tax jurisdictions around the world – has long been discussed as an option for improving the customer experience for taxpayers in the U.S.,” said IRS Commissioner Danny Werfel.
“The IRS review looked at the potential operational and administrative requirements of such a system. Ultimately, the results show there is taxpayer interest in an optional Direct file program and such a program is technically feasible. Any path forward should start with a limited pilot to assess operational factors described in this study.”
Werfel makes clear that any IRS program would supplement, not replace, private-sector options.
“Taxpayers will always have choices for how they file their taxes,” he said. “People should use the filing option that works best for them.”
Read the Commissioner’s entire letter to Treasury Secretary Janet Yellen that accompanied the Direct File Report.